Financial Q&A: Does your brokerage account have enough insurance?

July 21, 2008

Q: Brokerage houses insure street accounts to a $500,000 limit. I have three accounts with the same firm – one in my name, one jointly with my wife, and one in an IRA in my name. Is the limit $500,000 on all three accounts, or $1.5 million?

B.H., via e-mail

A: The insurance you refer to comes from the Securities Investor Protection Corp. and is commonly known as SIPC insurance. The corporation was created in 1970 primarily to protect investors from the insolvency or bankruptcy of a member broker-dealer (or clearing firm) that holds assets for investors and to provide coverage for "unauthorized trading" in a client account.

Michael Borato, a financial planner with Dawson Wealth Management in Cleveland, says that the insurance covers registered securities (most stocks, bonds, and mutual funds) and up to $100,000 in cash. It does not cover unregistered investments such as fixed-annuity contracts, hard commodities, commodity options, or futures contracts. Nor, he points out, does it extend to market risk or the volatility of any investment.

SIPC provides coverage of up to $500,000 per customer, per registration. One customer can act in several capacities: as owner of a single account, joint owner, Roth IRA owner, traditional IRA owner, or trustee, among others. Each of those accounts would be separately and fully covered up to $500,000. So if your accounts included all registered securities and no more than $100,000 in cash per account, Mr. Borato says they would be SIPC-insured up to $500,000 per account, for a total of $1.5 million for all three.

Most broker-dealers and clearinghouses registered with the Securities and Exchange Commission are SIPC members and those who are not must clearly disclose this to their clients. The member broker-dealers provide the funding for this insurance pool.

Q: I sold a property for $45,000. I bought it nine years ago for $35,000. If I put $17,000 of it toward new roofs on two other properties, kept $10,000 for myself, and put the balance back toward the principal of my other properties, would I have to pay capital gains on the proceeds?

A: Unfortunately, the answer is yes. "It is taxable," says Larry Woolever, a certified public accountant in Santa Barbara, Calif. Worse yet, he says that the entire $10,000 gain will be taxed, even though some prior planning could have chipped away at that, or deferred it.

The principal code that might have applied here, Mr. Woolever says, is Section 1031, which permits investor-owners to defer capital-gains taxes on proceeds that they roll into a new, similar investment. But that loophole has to be arranged at the time of the sale of the original investment and can't be applied retroactively.

Sadly, with a little counseling up front before the sale, there might have been a way to keep the sale tax-free.